As Argentina prepares to face the Netherlands for a place in the World Cup final, off the pitch the country has been caught up in another battle over its debt – one that could have far-reaching consequences.
On 16 June 2014, the US Supreme Court let stand a series of lower-court rulings that could alter the way governments handle debt crises. The decision ends the battle between the government of Argentina, which defaulted on more than $80 billion in foreign bonds in 2001 and restructured most of them in 2005 and 2010, and Elliott Associates, an investment company that has been pursuing distressed governments in court for decades. For other debtors, creditors and providers of financial-market services, the battle is just beginning.
In a succession of rulings that began in 2011, federal courts in New York ordered the Argentina government not to pay creditors who reduced their claims by as much as two-thirds, unless it also paid full principal and past-due interest to the small minority of creditors led by NML Capital (an Elliott affiliate), who refused Argentina’s debt-restructuring offers. The courts used their interpretation of the pari passu (equal step) clause in Argentina’s debt contracts, which promised an unspecified measure of equality to its foreign creditors, to mandate full payment to holdouts. The courts also threatened contempt sanctions against anyone – clearing houses, payment systems, financial-market service providers around the world – who might help Argentina continue paying its restructured debt. The country now faces the choice of paying as much as $15 billion to all its holdout creditors, who hold almost identical contracts, or defaulting on more than $25 billion in performing restructured debt and triggering a domestic economic crisis.
Argentina tried to pay its restructured foreign bonds on 30 June, but was blocked by the court. It was left with a 30-day grace period to settle with the holdouts and avoid default. This period will be fraught for the immediate participants in the drama – Argentina, the holdouts, the restructured bond holders, trustees – but the implications of the US court decisions for the broader sovereign debt market are more significant. Thanks to these decisions, previously unenforceable debt contracts can now be enforced using a form of judicial boycott. While the indebted government might try to defy court orders, pay its restructured debt and use sovereign immunity to shield its property from creditor lawsuits, no financial institution with a presence in New York would risk dealing with it for fear of court sanctions. The defiant debtor can no longer live the normal financial life of a government in the global economy.
To be sure, both Elliott and Argentina are extreme in their own ways. Most creditors faced with an immune government cannot and do not chase it around the world for over a decade. They bargain hard, but ultimately accept the government’s debt restructuring offer. On the other hand, few countries have the resources or the political will to run from their creditors for decades, since without bankruptcy, the debt never goes away. Like most creditors, most governments prefer to settle. Elliott and Argentina chose to fight, and in the course of their fight have exposed the dubious foundation of the sovereign debt market. The court rulings from their fringe contest will apply to every country and every creditor henceforth.
This means that a country in debt trouble can no longer tell its creditors that if they refuse to restructure, they may go unpaid. Instead, holdout creditors stand a decent chance of holding the country and its restructured creditors to ransom unless and until they are paid in full. On the other hand, creditors contemplating a government’s restructuring offer must not only contemplate the size of their impending “haircut”, but also the possibility that they will never see their reduced payments, because a holdout might interrupt them. Even the bravest creditor would hesitate to jump in.
For now, contract reform remains the most promising and pragmatic way forward. The IMF and the London-based International Capital Market Association have separately proposed removing or modifying the pari passu clause, and adding robust majority-voting provisions in sovereign bonds. The new voting mechanism would operate across the entire stock of the distressed government’s bonds, so that if a supermajority of creditors supports the restructuring, holdouts with blocking positions in individual bond issues could not stay out of the deal and free-ride on the rest. Trustees, payment and clearing systems could speed up reform by conditioning access to their services on these and other contract changes, which makes them less vulnerable to being commandeered by holdout creditors.
In the long run, the market will surely adapt. This is small comfort to the poor countries, ordinary creditors, financial-market service providers and taxpayers in debtor and creditor countries alike, who will suffer through the fallout from Elliott and Argentina for years to come.
Author: Anna Gelpern is a professor at Georgetown University Law Centre and a non-resident senior fellow at Peterson Institute for International Economics.
Image: A man walks past an electronic board showing currency exchange rates and an Argentine flag at a money exchange in Buenos Aires. REUTERS/Marcos Brindicci